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Pricing …. again

August 24th, 2012

If there is one universal critical success factor for all businesses pricing must be close to the top of the list and yet it is the least understood and most frequently abused tool in the management armory.  How often do you hear a client say I can’t raise my price because I’ll lose all my customers?  Maybe you even have the same view about your own pricing.When I was in practice I’d always asked a client if s/he felt more revenue was required to improve the profitability of the business and you guessed it, the answer would almost always (as in 99.9% of the time) be of course!  I would then ask “and how do you think you might be able to achieve that?”  And the answer to that question was inevitable something along the lines of “well …. we can’t raise our prices because we’d loose too much business” or they might say “perhaps we could spend more on advertising.”

I can’t think of a single occasion when the answer was along the lines of “well …. maybe we should be looking at ways we can create more value for our customers in ways other than by lowering prices.  For example perhaps we could put more effort into our service protocols or …. maybe, we should talk to our customers (or at least the ones we know are profitable to deal with) about what they value about our products and our service.”

If more people thought along these lines their margins would not be continually eroded and they would not have to continually keep driving revenue forward to generate the amount of gross profit to maintain (and would I be out of line if I said actually GROW) their profit.

The margin analysis that GamePlan performs shows clearly the absolute folly of discounting to grow revenue.  It’s extremely common to see people offering 10% discounts in an attempt to drive revenue.  If you do this, and let’s say your current GP% is 30%, you’ll need additional sales volume of 50% just to stand still!  Few businesses even have that amount of spare capacity even if the market was responsive to the offer.

And that brings me to an interesting post I recently noticed on Holden Advisors newsletter website –  Reed Holden is an expert on pricing and has written several excellent books on the subject.  One of his books that was recently published is appropriately called Negotiating With Backbone.  I have not read it yet but have ordered it after reading his other work and reviewing the TOC.

Anyway, the newsletter was talking about the fundamental problem with Groupon’s business model — for those of you who do not know about Groupon go to www.groupon.com and check it out; it’s an online service that promotes really good deals from other businesses (principally food, personal service and retailers etc) but its stock price has tanked since its celebrated IPO last year.

Essentially the problem is although people are responsive to price when the discounts are deep enough this is not good business for the vendor which means in the long run the only beneficiary is going to be the customer and since Groupon’s customer is the service vendor the future of that business model is flawed.

The author of the article I was referring to who I believe is Ellen Quackenbush made the following comments that I think are worth noting.  Note in particular here comment about the Rice University study. 

  • Capacity: If retailers do not specify the equivalent of black-out dates used by the airlines, they risk being overwhelmed by unexpected surges in customer demand, crowding out higher-paying regulars. Groupon has introduced a scheduler to try to help small businesses predict demand, but this fence should be built into coupon offers themselves.
  • Cost: Unless a retailer is selling off excess inventory or filling spare capacity, coupons can be a money-loser. Rice University found that only half of small businesses turn a profit on daily deals and convert less than 20% of bargain-hunting couponers into full-price repeat customers.
  • Brand value: The worst impact may be on the retailer image. Price buyers are great for filling capacity but not for building long-term brand equity. Our research into buying behavior would warn that buyers do not change their stripes. Even a great staff will find it hard, if not impossible, to convert a price buyer into a relationship or value buyer.
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